1Chapter 4Consumer ChoiceKey issues1. properties of preferences2. utility3. budget constraint4. consumer's constrained choiceQuestions1. rationing of visits by Californians to Yosemite 2. challenge grants3. effect of subsidized move to another city 4. are poor people necessarily better off getting cash or a comparable amount of food stamps?2Individual decision making• individual tastes (preferences) determine pleasure people derive from goods• consumers face constraints on their choices• consumers maximize their pleasure from consumption subject to constraints • we want to predict behavior - not judge itConsumer’s problem• consumer allocates money over goods: buys a bundle or market basket of goods• 2 possible theories of consumer behavior• maximizing behavior• random behaviorAssumptions about consumer preferences1. completeness2. transitivity3. more is better3Assumption 1: Completeness• consumer can rank any two bundles of goods• only one of following is true: consumer • prefers Bundle x to Bundle y• prefers Bundle y to Bundle x• is indifferent between themAssumption 2: Transitivity (rationality)• consumer's preference over bundles is consistent:• if consumer prefers• Bundle z to Bundle y and• Bundle y to Bundle x• then consumer prefers Bundle z to Bundle xAssumption 3: More is better• more of a good is better than less of it• good: commodity for which more is preferred to less at least at some levels of consumption• bad: something for which less is preferred to more, such as pollution• consumers are not satiated4Which assumptions are critical for our model?• completeness and transitivity assumptions are crucial• more-is-better assumption is included only to simplify the analysisWhy do economists make the more-is-better assumption? • it appears to be true about most people• with free disposal, you can't be worse off with extra goods• consumers only buy goods where this condition is met (we'll show later)Preference maps• we summarize information about a Lisa’s preferences using a graph• we can rank some bundles using more-is-better assumption5Figure 4.1a Bundles of Pizzas and Burritos Lisa Might ConsumeB, Burritosper semester(a) Ranking Regions302515Z, Pizzas per semester252015100dabecfABIndifference curve• we ask Lisa to identify all the bundles that give her the same amount of pleasure as consuming bundle e• her answer: Curve I in Figure 4.1b, “Indifference Curve”Figure 4.1b Bundles of Pizzas and Burritos Lisa Might ConsumeB, Burritosper semester(b) Indifference Curve302515Z, Pizzas per semester252015100dabIecf6Indifference or preference map• complete set of indifference curves that summarize a consumer's tastes• Figure 4.1c shows parallel curves, but they need not be parallelFigure 4.1c Bundles of Pizzas and Burritos Lisa Might ConsumeB, Burritosper semester(c) Preference Map302515Z, Pizzas per semester252015100dI0I1I2ecfIndifference curve properties1. bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin2. there is an indifference curve through every possible bundle3. indifference curves cannot cross4. indifference curves are “thin”5. indifference curves slope down7Property 1: Higher utility on farther indifference curves• bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin• by more is better assumptionFigure 4.1c Bundles of Pizzas and Burritos Lisa Might ConsumeB, Burritosper semester(c) Preference Map302515Z, Pizzas per semester252015100dI0I1I2ecfProperty 2: Indifference curve through every possible bundle • by completeness: A consumer can compare any bundle to another • compared to a given bundle, some bundles are• preferred, • enjoyed equally•inferior • connecting bundles that give the same pleasure produces an indifference curve that includes the given bundle8Property 3: Indifference curves cannot cross• assume the opposite: two indifference curves cross at Bundle e in Figure 4.2a.• look for a contradictionFigure 4.2a Impossible Indifference CurvesB, Burritosper semester(a) CrossingZ, Pizzas per semesterI1I0abeProperty 4: Indifference curves are "thin"• assume the opposite: suppose an indifference curve were thick (Figure 4.2c).• look for a contradiction9Figure 4.2c Impossible Indifference CurvesB, Burritosper semesterab(c) ThickZ, Pizzas per semesterIProperty 5: Indifference curves slope down• assume the opposite: indifference curve Islopes up in Figure 4.2b• look for a contradictionFigure 4.2b Impossible Indifference CurvesB, Burritosper semester(b) Upward SlopingZ, Pizzas per semesterIab10Willingness to substitute• downward-sloping indifference curve ⇒consumer is willing to substitute one good for the other• marginal rate of substitution (MRS) of burritos (rise) for pizza (run), is slope of indifference curve:BMRSZ∆=∆MRS varies along the indifference curve• indifference curve bow away from the origin (convex)• indicates diminish marginal rates of substitution (MRS) Figure 4.3a Marginal Rate of SubstitutionB, Burritosper semester(a) Indifference Curve Convex to the Origin5381–11120–2–33456Z, Pizzas per semesterabcdI11Concave indifference curve• if indifference curve bows toward the origin (concave) • then (implausibly) increasing MRSFigure 4.3b Marginal Rate of SubstitutionB, Burritosper semester(b) Indifference Curve Concave to the Origin571120–2–33456Z, Pizzas per semester abcIPerfect substitutes• straight line indifference curves• if slope is –1, MRS = 1 (Coke-Pepsi)12Figure 4.4a Perfect Substitutes, Perfect Complements, Imperfect SubstitutesCoke, Cansper week(a) Perfect Substitutes1234Pepsi, Cans per week10234I1I2I3I4Perfect complements• right-angle indifference curves•MRS= 0 (Coffee-Cream)Figure 4.4b Perfect Substitutes, Perfect Complements, Imperfect SubstitutesIce cream,Scoops per week(b) Perfect Complements123Pie, Slices per week1230I1I2I3adecb13Imperfect substitutes• convex indifference curves• lies between the two extremes (straight and right-angle indifference curves)Figure 4.4c Perfect Substitutes, Perfect Complements, Imperfect SubstitutesB, Burritosper semester(c) Imperfect SubstitutesZ, Pizzas per semesterIApplication: Food vs. clothing• indifference curves of the average U.S. consumer between food consumed at home and clothing• as we move away from the
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